US institutional investors favouring alternative mutual funds over hedge funds

 

"Alternative mutual funds and ETFs have grown in breadth and quality in recent years," says Nadia Papagiannis, director of alternative funds research for Morningstar. "Institutional investors are starting to see alternative mutual funds as substitutes for hedge funds, and more financial advisors are incorporating these liquid, transparent investments into their client portfolios."

 

Morningstar and Barron’s conducted the survey in March 2013 and received responses from 235 institutions and 471 financial advisors. Among the major trends in alternative investment usage and perception:

 

Mutual funds are becoming the dominant vehicle used by both advisors and institutions to access the majority of alternative strategies. Alternative mutual funds saw inflows of USD19.7bn in 2012, while Morningstar estimates that among funds in its database, USD7.6bn flowed out of single-strategy hedge funds.

 

While 61 per cent of institutions said they accessed long-short strategies via hedge funds in 2010, only 26 per cent indicated that they used hedge funds for that strategy this year. In contrast, more than 45 per cent of institutions said they access long-short strategies via mutual funds versus 38 in 2010.

 

Among institutions, the number of "heavy users" of alternatives seems to be growing. More than 20 per cent of institutions, compared with 17 per cent last year, said they expect alternative investments to make up more than 40 per cent of holdings over the next five years.

 

Only four per cent of advisors said their typical client had no money in alternative investments, down from 17 per cent in the 2008 survey.

 

In 2012, the long-short equity and non-traditional bond categories saw the largest alternative mutual fund flows of USD6.1bn and USD5.9bn, respectively.

 

For the second year in a row, institutions again flagged long-short equity strategies as their top choice for increased allocation—the strategy ranked second for advisors.

 

Advisors also expressed particular interest in yield-producing alternatives. They cited private real estate as their top strategy for planned future investment. In addition, advisors indicated that master limited partnerships (MLPs) drove significant portfolio growth over the last five years.

 

Advisors shied away from managed futures in 2012 after citing them as their top pick in the two previous surveys. Performance may have been a factor as managed futures ETFs and mutual funds lost 15.6 per cent and 7.4 per cent, respectively, in 2012, similar to their losses in 2011. Institutions and advisors also expressed distaste for the undisclosed performance fees managed futures funds frequently charge.

 

High fees have overtaken liquidity and transparency as the primary reasons why advisors and institutions may choose to forego alternative investments.